Friday, August 26, 2011

The good news about bank lending just keeps on a comin'. I've been featuring this chart for most of this year, and regularly get comments that challenge its message. Despite the popular perception that banks aren't lending, and despite the fact that many small and medium-sized businesses can't seem to get their bankers to lend them some badly-need money, banks are nevertheless expanding the amount of loans to small and medium-sized businesses, as this chart shows. C&I Loans outstanding have grown at about a 10% rate since late last year.

The important thing is not that more loans are going to create more GDP, it's that more loans are the result of an increased desire on the part of banks and businesses to take on more risk. Risk-aversion was one of the things that contributed significantly to the 2008-9 recession, so a move towards less risk-aversion is likely to help the economy improve.

To put things in context, though, a 10% increase in this type of lending only amounts to a drop in the bucket. Banks are sitting on $1.6 trillion of excess reserves, which means they could—if they wanted to, and could find willing borrowers—expand their loans by many orders of magnitude more than they have to date.

I spoke with a senior credit officer at a bank here in Atlanta and he said there is barely any improvement in loan activity. He said the federal regulators have made it almost impossible for his bank to issue new loans.

I think your banker friend has a point. Regulators have been on the warpath with banks and other private sector participants for nearly three years. IMO unless this is curtailed and some confidence is restored, we will be fortunate to avoid another recession, much less restore normal growth rates. There needs to be a complete and final settlement between the government and the banking industry over improper mortgage activities since 2008. We are coming up on three years since the crisis and continuing the witch hunts for wrongdoers is not helpful to restoring job growth. The economy needs confident borrowers and lenders if faster growth is to be achieved.

The President will unveil his plans for economy in a few days. A peace treaty between government and the private sector, starting with the banks is at the top of my wish list.

Why is this good news? Banks lending more money they've created from the void is a good thing?

And risk aversion was a secondary consequence of the bust following the artificial housing boom, not a cause.

People should be risk-averse right now, the economy is about to head over a cliff. Why is it a good thing in your opinion that people are acting more risky?

Banks are sitting on $1.6 trillion of money created out of thin air. God forbid they begin to lend it out. It won't help the economy one iota. The economy needs to rebalance, not get another sugar high from the Fed.

The 3-yr average of the CPI (0.95%) is at its most misleading right now because of its starting point. Assuming only a 0.2% rise in the monthly CPI going forward, the 3-yr rate will rebound to 2.5% by December.

In the modern monetary system banks do not lend reserves. They are only lending constrained by a) capital requirements b) willingness to lend and c) demand for new funds by creditworthy borrowers. So the increase in reserves will not someday be "lent out," as the neoclassical money multiplier theory would suggest. See recent papers by the BIS and NY Fed for further support of something that has been known for some time.

That is why QE is not inflationary, and is not stimulative. Adding to bank reserves (by removing longer term securities) does not a) add net financial assets to the private sector or b) remove a constraint that is otherwise binding. There is no transmission mechanism from QE to the real economy, aside from transitory "portfolio reblance channels" that may, from time to time, provide an illusion of recovery through asset price increases.

The overindebted (and underemployed) private sector is not in position to demand new funds, and explains why borrowing will be muted until this condition is cured. Credit deflation is the signpost for depressionary conditions, e.g. Japan.